What to be aware of before you invest in hedge funds
◆ Skewed indices. RE:CM executive chairman Piet Viljoen says you should not rely on hedge fund indices, because they have two major problems:
❑ Backfill bias. If, for example, there are five hedge funds, and three are unsuccessful and two are successful, hedge fund managers will populate the index with the successful funds, while the unsuccessful funds will not make it into the index.
❑ Survivorship bias. As soon as a hedge fund closes or goes insolvent, it is removed from the index, along with its performance history.
◆ Stable assets under ◆
management. Viljoen says there are good hedge funds and good hedge fund managers out there, but they are very private, very selective regarding their clients, and not easy to access.
“A good hedge fund manager is not the guy with 20 irons in the fire but a manager who is doing one thing, has been doing it for a long time and is doing it well. Such a manager will have stable assets under management rather than being an asset gatherer.
“Fund managers who practise asset-gathering are generally acting only in their own interests. An easy way to spot such managers is by the number of different products (or funds) they manage. Any more than five or six should send out a strong red flag to investors,” Viljoen says.
The fund manager’s ethics. This includes the fees the manager charges, product proliferation, his or her attitude towards disclosure, and communication with prospective and existing investors.